Relationship with Money
A blog that knows money is more than numbers
138 | Limited Options
How can the specific investments be the linchpin to personal financial health when workplace retirement plans are typically limited to 15 or 20 fund options?
Of the more than 15,000 funds available, each workplace plan has 0.001% of the fund universe available to its participants.
As a society, I just don’t think we’ve settled for a random assortment of subpar investments for the $26 trillion dollars that sit across 80 million individual’s accounts.
That would be an enormous number of folks asleep at the wheel or an epic orchestration by the investing Illuminati to keep lay people away from the good stuff.
Not to get carried away jumping to conclusions, but limited options also feel like a hint that limited tweaking might be a reasonable investment strategy too.
133 | A Stock Picker’s Anthem
After a day of sitting through pitches from different mutual funds, I couldn't help but write a lyric summarizing each of their strategies.
While each fund wanted to highlight their unique differences, they all sounded so generically the same.
Thank you to Sir Mix-a-Lot for the inspiration...
I like big moats and I cannot lie.
Strong balances sheets are so fly.
When it's got good management.
And it trades below intrinsic.
I go long!
130 | A Statement of Belief
In a world where most everyone wants most everything to be free, it's not surprising that investment strategies have been reduced to minimizing costs.
The expense ratio is a crude measurement of resources spent by a fund to generate investment returns.
And it has become the "whack-a-mole-hammer" for the do-it-yourself investor and the bane of existence for a fund manager in any investing conversation.
Contrary to popular belief, it does not represent fees that are arbitrarily deducted from returns by a fund manager or a financial advisor.
The expense ratio is only a back of the envelope calculation completed after the fact to summarize money spent by a fund visiting, meeting, analyzing, and administrating the actual investment in companies across the world.
The expense ratio is not someone else's "cut" of your returns.
This feels nuanced, but I think it's important.
Lower expense ratios have been found to correlate with higher returns, but they don't cause higher returns.
Finding the lowest expense ratio is more a statement of belief that effort and research don't lead to higher returns than it is a discount code to be used at checkout.
Of course, as costs go down, intentionality tends to decrease too, but that's a more nuanced conversation for another day.
129 | No Tweaks
It's one of the hardest investing concepts to grasp because it goes against every grain inside and outside of our being.
Marketing from financial services firms tempts us to tweak.
Daily price quotes, other people talking about their investments, and market-wide downturns tempt us to tweak too.
But when we think about making tweaks, our gut instinct is to say, "That stock or fund has performed well over the past few years - I want more of it in my portfolio."
Then without even meaning to do it - we're buying high and greasing the skids to sell low.
Read that again, because it's literally the exact opposite of the single piece of advice that everyone in the world has heard about investing.
We don't refrain from tweaks because we're lazy.
We do it because it's the hard thing to do, which is often a good sign that it's the secret to success too.
127 | The Line of "Free" Returns
When it comes to evaluating investment performance, it's easy to get confused with benchmarks.
How am I doing relative to the S&P 500? Or Apple? Or CDs? Or the Russell 2000? Or my neighbor?
On their own, none of these are particularly helpful benchmarks.
I'd argue that the benchmark is the investing strategy that requires the least time, attention, and money to implement.*
If you are invested in 100% stocks then you can compare your returns to the average of all the publicly-traded stocks in the world to confirm that you're capturing the "free" returns that are available to you (and everyone else!).
If you are invested in 100% bonds then you can compare your returns to the average of all the publicly-traded bonds in the world to draw similar conclusions.
And if you are invested in a blend of stocks and bonds, then there is a clear line connecting "all the stocks" and "all the bonds" that serves as The Line of "Free" Returns.
Of course, "free" is a loaded term.
Just because the financial cost of investing continues to trend to $0, doesn't mean there aren't psychological and emotional costs to investing - Morgan Housel describes the fact that nothing's free better than anyone.
Follow the link below to see how your personal investment performance compares to the "free" returns that are available to you.
And don't make Mistake #1 by assuming that your professionally-managed investments are capturing the "free" returns!
*In my mind, interest paid on cash in a bank account does not count as "investing". Nor does owning something that can't generate revenue (and profits!) for its creation of real human value in the world (i.e. gold, cryptocurrency, commodities, etc.) - those are better described as "speculating".
126 | Nothing’s Free
An excerpt from The Psychology of Money by Morgan Housel...
Everything has a price, and the key to a lot of things with money is just figuring out what that price is and being willing to pay it...
...The S&P 500 increased 119-fold in the 50 years ending 2018. All you had to do was sit back and let your money compound. But, of course, successful investing looks easy when you're not the one doing it.
"Hold stocks for the long run," you'll hear. It's good advice.
But do you know how hard it is to maintain a long-term outlook when stocks are collapsing?
Like everything else worthwhile, successful investing demands a price. But its currency is not dollars and cents. It's volatility, fear, doubt, uncertainty, and regret—all of which are easy to overlook until you're dealing with them in real time.
The inability to recognize that investing has a price can tempt us to try to get something for nothing. Which, like shoplifting, rarely ends well.
Say you want a new car. It costs $30,000. You have three options: 1) Pay $30,000 for it, 2) find a cheaper used one, or 3) steal it. In this case, 99% of people know to avoid the third option, because the consequences of stealing a car outweigh the upside.
But say you want to earn an 11% annual return over the next 30 years so you can retire in peace. Does this reward come free? Of course not. The world is never that nice. There's a price tag, a bill that must be paid. In this case it's a never-ending taunt from the market, which gives big returns and takes them away just as fast.
Including dividends the Dow Jones Industrial Average returned about 11% per year from 1950 to 2019, which is great. But the price of success during this period was dreadfully high. The shaded lines in the chart show when it was at least 5% below its previous all-time high.
This is the price of market returns. The fee. It is the cost of admission. And it hurts.
Like most products, the bigger the returns, the higher the price.
Netflix stock returned more than 35,000% from 2002 to 2018, but traded below its previous all-time high on 94% of days. Monster Beverage returned 319,000% from 1995 to 2018-among the highest returns in history—but traded below its previous high 95% of the time during that period.
Now here's the important part. Like the car, you have a few options: You can pay this price, accepting volatility and upheaval. Or you can find an asset with less uncertainty and a lower payoff, the equivalent of a used car. Or you can attempt the equivalent of grand-theft auto: Try to get the return while avoiding the volatility that comes along with it.
Many people in investing choose the third option. Like a car thief - though well-meaning and law-abiding - they form tricks and strategies to get the return without paying the price. They trade in and out. They attempt to sell before the next recession and buy before the next boom. Most investors with even a little experience know that volatility is real and common. Many then take what seems like the next logical step: trying to avoid it...
...The irony is that by trying to avoid the price, investors end up paying double...
...The question is: Why do so many people who are willing to pay the price of cars, houses, food, and vacations try so hard to avoid paying the price of good investment returns?
The answer is simple: The price of investing success is not immediately obvious. It's not a price tag you can see, so when the bill comes due it doesn't feel like a fee for getting something good. It feels like a fine for doing something wrong. And while people are generally fine with paying fees, fines are supposed to be avoided. You're supposed to make decisions that preempt and avoid fines. Traffic fines and IRS fines mean you did something wrong and deserve to be punished. The natural response for anyone who watches their wealth decline and views that drop as a fine is to avoid future fines.
It sounds trivial, but thinking of market volatility as a fee rather than a fine is an important part of developing the kind of mindset that lets you stick around long enough for investing gains to work in your favor.
Few investors have the disposition to say, "I'm actually fine if I lose 20% of my money." This is doubly true for new investors who have never experienced a 20% decline.
But if you view volatility as a fee, things look different.
Disneyland tickets cost $100. But you get an awesome day with your kids you'll never forget. Last year more than 18 million people thought that fee was worth paying. Few felt the $100 was a punishment or a fine. The worthwhile tradeoff of fees is obvious when it's clear you're paying one.
Same with investing, where volatility is almost always a fee, not a fine.
Market returns are never free and never will be. They demand you pay a price, like any other product. You're not forced to pay this fee, just like you're not forced to go to Disneyland. You can go to the local county fair where tickets might be $10, or stay home for free. You might still have a good time. But you'll usually get what you pay for. Same with markets. The volatility/uncertainty fee-the price of returns—is the cost of admission to get returns greater than low-fee parks like cash and bonds.
The trick is convincing yourself that the market's fee is worth it. That's the only way to properly deal with volatility and uncertainty-not just putting up with it, but realizing that it's an admission fee worth paying.
There's no guarantee that it will be. Sometimes it rains at Disneyland.
But if you view the admission fee as a fine, you'll never enjoy the magic.
Find the price, then pay it.
125 | The Case for Ignorance
For some reason, many people think they should be more in tune with their investments than they are.
It's some mixture of guilt, embarrassment, or feeling like “being in tune” is what it means to be an adult.
But I'm not certain this is a reasonable or appropriate expectation.
We don't expect everyone to be able to play a guitar riff. Or cook a gourmet meal. Or run a half marathon. Or moderate a heated discussion.
I don't know why investments should be any different, but scrolling stock tickers on CNBC and annual investment updates with an advisor often contradict this belief.
Once we've cared for a few important basics, I'd argue that the less we know, the better off we will be.
Most investment performance analysis reduces investment return to a single number.
"For the past 10 years, this investment has returned 8% annualized."
But that is comically misleading - it's not far from assuming a tombstone with a birth date and a date of death is the entire life story of the person who passed.
One way to an 8% return over a decade is investment gains for 7 or 8 years followed by investment losses to close out the decade. This could look like...
But how cheap is the line?
It doesn't begin to capture the emotion of the last two years - a line doesn't capture the emotion of feeling less wealthy than you once were. Or the envy of your prior self. Or the temptation to make a change. Or the paralysis of not wanting to do anything for the next few years until you get back to your arbitrary high-water mark.
Another way to an 8% return over a decade is investment losses or modest gains for 7 or 8 years followed by phenomenal investment gains to close out the decade. This would look like...
But this line is as cheap as the first one.
It fails to capture the second-guessing, self-doubt, frustration, or temptation to abandon the plan for the first 7 or 8 years of the decade. There aren't many feelings in finances that are harder to navigate than the persistent question of "Am I doing this all wrong?" - and assuming that the tuned-in investor can push that question off for 8 years to experience the pay off in years 9 and 10 is extending quite the benefit of the doubt.
Another way to an 8% return over a decade is lack of awareness around exactly how it came to be. This would look like...
At seeing those starting and ending points, I think most people would be surprised, amazed, grateful, or even struggle to comprehend how it happened. No second-guessing, no comparison to others, no wondering what could have been, and no arbitrary high-water marks. Just awe over progress that came from money working for them.
It doesn't take a PhD to realize which set of emotions you'd prefer to experience over a decade or lifetime.
Once you've cared for some basics, I think it's OK to be a little ignorant.
108 | It Might Not Work
It seems we have forgotten the underlying tension in investing.
It might not work.
Partially because of the phenomenal returns of the past decade.
Partially because of how slick technology has made some investing look like a video game.
Partially because of the second-by-second price quotes that make it seem like the price is more important than the profit.
Partially because of the way investing and all of our investment options are marketed to us.
It's become too easy to think investment returns are a birth right or a handout from Oprah when they are actual ownership stakes in businesses.
Businesses with employees - the you and me's of the world - who are delivering goods and services for a profit - most days.
The key word in that last sentence is most, because it's not all.
Every business doesn't make it, which means every investment doesn't work.
But this isn't any different than other parts of life.
When an author is afraid that the word processor they use to save their work might not work, what do they do?
They save a second copy.
When a football team is afraid that the quarterback they have chosen as starter might not work, what do they do?
They sign a backup.
When a traveler is afraid that a new restaurant might not work, what do they do?
They find another option.
If we’re afraid an investment in a business might not work, what do we do?
We find another one, and another, and another, and another until we’re comfortable knowing that it’s OK that one might not work.
99 | Life Below the Personal Record
At some point in any athletic pursuit, we experience some level of peak performance - the first lifetime peak is usually a season where physical ability covers over most other shortcomings.
It’s different for everyone, but often the first peak coincides with a season of life characterized by youth, unrealistically high frequency of reps, and fewer competing priorities.
Over time, the memory of the peak tends to lead us one of two directions - it can inspire and remind or it can discourage and haunt.
When we are haunted, inevitably we push ourselves to injury, grumble about the good old days, or throw in the towel because it’s no fun to play if we can’t compete with a younger self.
A lifetime of investing isn’t that different from that of an athlete.
The S&P 500 reaches a new all-time high on ~5% of its trading days. All-time highs are exhilarating, confidence-instilling, and full of dopamine - much like a new personal record.
But this also means that ~95% of its trading days, the S&P 500 is the veteran athlete wishing that it could be more like it’s younger self.
That’s a lot of days longing to beat or even match a personal record.
On the investment side of things, the haunting looks like grumbling about recent performance, reaching for extra return in a reckless manner, or deciding that you might as well stop investing before it all goes to $0.
Life below the personal record can drive us crazy not because it’s that bad, but because it’s relatively worse than where we once were.
The trick is not using brute force or discovering a fountain of youth that can take us back to a previous time.
It’s more of a mental game than that.
Some blend of recognizing that you can’t set new personal records in perpetuity, so when the times are good you can actually recognize that they are in fact the good times. Thank you, Andy Bernard.
And an understanding that the only thing that allows you to set a new personal record is your mindset while you’re living below the last one.
Additional Resources
Compounding in the Stock Market is Messy by Ben Carlson
Same Return. Different Emotions. by Money Visuals
98 | My Thoughts on Investment Properties
Once you find an actual property that is available for purchase, I think it makes sense to figure out an estimate of what you could charge for rent.
If that level of rent is acceptable to you, then I think it could be quite worthwhile to pursue as an investment.
The end.
P.S. It’s also OK if generating income isn’t the primary reason for pursuing an additional property.
73 | Bad Words
A "bull market" is when stock prices rise by 20% after two declines of 20% each.
It's only identified after the fact.
Let me repeat - it's only identified after the fact.
On June 8, 2023, the Wall Street Journal informed us of the following, "S&P 500 Enters New Bull Market".
The market is up 20% since October 2022 and in June 2023 the Wall Street Journal says we're "entering a bull market".
What a joke.
If you've been waiting for the "start-of-the-bull-market" headline you've already missed out on a 20% rebound.
What's brutal is that the headlines of the past six months have been all doom and gloom - inflation, interest rates, debt ceiling, layoffs, etc. and yet a "bull market" has happened right in front of our eyes. The same way it always happens.
My guess is that a lot of people feel more comfortable investing after reading a headline like that, but they've missed out on a good chunk of the return that's already been made.
A beautiful example of financial terminology only adding to the confusion of personal finance.
This is bad enough, but here is where it's going to get tricky.
A "recession" is a period of temporary economic decline during which GDP falls in two consecutive quarters.
It's only identified after the fact.
There's a decent chance that the past 6 months will be declared a "recession" once the bean counters get around to closing the books.
It's not a signal of bad news. It's just confirmation that all the doom and gloom that you just lived and felt is in fact what the numbers say too.
It's a little like playing a basketball game without a scoreboard. If the other team full court pressed you into turnovers, got all the offensive rebounds, and made half of their 3s, the scoreboard isn't really necessary and can only confirm what you have already felt and experienced.
The existence of the scoreboard doesn't change what happened on the court and it certainly doesn't tell us anything about the outcome of the next game.
Just like the scoreboard, declaring a "recession" doesn't change the experience of the past 6 months and it doesn't tell us anything about the next 6 months either.
Be careful of finance words - they're rarely as helpful or informative as they seem.
72 | In Defense of Values-Based Investing: Right and Smart
This is not a sales pitch for Eventide Investments, but their investment process and commentaries illustrate the mysterious third factor better than anyone else I have ever read or seen.
Shaun Morgan says, "The true measure of success for a business lies in its ability to generate a profit by creating value. But profits generated by extracting value often have a limited lifespan. Profits generated by creating value, on the other hand, have the propensity to rejuvenate and sustain themselves."
An ability to identify and own companies that have been, are, and will continue creating the truest form of value for the world will lead to out-performance over long periods of time.
Eventide goes further by describing how a company that creates value interacts with each of its stakeholders in their Business 360 process...
When a business delights its customers, they become loyal patrons and go on to promote it to their friends and family, but when it disregards its customers, they walk away and tell others to steer clear.
When a business supports its employees, they give their best to their work, but when it neglects its employees, they in turn neglect their work or quit.
When a business cultivates a sustainable, humane supply chain, suppliers deliver quality goods and services, but when it mismanages its supply chain, suppliers and their workers suffer and deliver lower quality goods and services.
When a business respects and invests in local communities, they see the business as a blessing and go on to support it, but when it ignores local communities, they see the business as a curse and may actively oppose it.
When a business preserves and cares for the environment, it nourishes and sustains productive yield as the business grows, but when it damages the environment, the company may run out of resources or even face litigation or environmental disaster.
When a business satisfies an important need for society, people delight in its products and services, growing the market, but when it harms society with its products and services, society suffers and condemns the business.
Anyone can appreciate that delighting, supporting, cultivating, respecting, preserving, and satisfying is going to lead to better outcomes for all stakeholders in the long run.
This kind of investing not only begins to define the mysterious third factor, but also is the best way to achieve greater returns and lower volatility over the long haul - making it both a worthy and a profitable pursuit, because "doing what is right is also doing what is smart".
Additional Reading
A paradox of status and power by Seth Godin
The Fourth Source of Alpha by Shaun Morgan
Introduction to the Business 360® Framework by Eventide Asset Management
71 | In Defense of Values-Based Investing: Cost Isn't Only Measured in Dollars
If defining the "mysterious" third factor is challenging, then actually executing a strategy that accounts for it is as nuanced, complex, and filled with constraints as anything in personal finance.
One set of nuance and complexity has to do with the level of due diligence and research dedicated to evaluating possible investments.
Whether you are doing the research yourself or hiring someone to do it for you, the process of evaluating companies through a personal set of values or beliefs is a tall task.
Time becomes the limiting factor if you're picking individual stocks and trying to evaluate each of them based on non-financial merits.
Trust and alignment of values become the limiting factors if you're trying to find a fund that will actively evaluate each company for you.
Accessibility and awareness become the limiting factors if you're looking for a private investment that might address the mysterious third factor.
Underneath all three approaches, the level of judgment intensity is a spectrum unto itself - it's one thing to avoid companies that fail to check certain boxes, but it's another thing entirely to only select companies that check all the boxes.
Then there are the technical and behavioral factors to consider too.
The more we limit the field of investment candidates, the harder it is to be diversified, which can lead to greater return, but also greater volatility.
The more we tighten up our criteria, the less correlated our returns will be to the greater market, which can challenge our level of conviction during the inevitable periods of under performance.
Each of these nuances is a hidden "cost" that can be worth paying, but like any hidden costs, the less you know about them before you start the more likely you are to be disappointed when they show up.
We can continue to talk theoretically about all the nuances, but like any other investment approach, outcomes are driven by the same themes of being diversified, deciding your blend between stocks and bonds, expecting to buy and hold for a long time, and being patient through the ups and downs.
As fun and rewarding as it can be to talk about "impact" and "flourishing" and "value creation", if we forget the fundamental themes then we aren't going to make it very far. And if we haven't cared for our own relationship with money, then most of the effort will be for naught.
But if we've acknowledged the nuances, cared for the basics, and tended to our own relationship with money, then the upside on all three factors - return, volatility, and that mysterious third - is quite a worthy pursuit...
70 | In Defense of Values-Based Investing: The Mysterious Third
Traditionally, the performance of investments has been measured using two primary factors.
The first and sexiest is investment return - how much did the investment grow over time? This is what you'll overhear people bragging about at a party or on social media.
The second is investment volatility - how smooth was the ride to achieve the return? You won't hear as much about this one, but I think it's what allows the most seasoned investors to sleep well at night and pat themselves on the back for a job well done.
Understandably, these two criteria are relatively easy to measure and compare across investments, so they've become factor 1A and 1B for analyzing performance over time.
From the start, there has always been a mysterious third factor that anyone could feel in their gut, but struggled to put into words.
Recently, as access to information has become more ubiquitous and timely, it has felt like defining this third factor is more within reach even though at times it's still as mysterious as ever.
Is the company actually creating value for people or is it extracting value from people?
Does the company contribute to the flourishing, in the most holistic sense of the word, of all people in the world?
Or does the company contribute to the continued deterioration, in the sneakiest sense of the word, of all people in the world?
The trouble is that distinguishing between value creation and extraction is hard.
Does Amazon create value by partnering with small businesses to allow them to connect with a larger footprint than ever before or does it destroy the fabric or our culture by sterilizing and globalizing the consumer experience?
Does a brewery perpetuate a society's challenges with alcohol or does it create a space for connection that combats society's struggles with loneliness, depression and anxiety?
Does a car manufacturer provide access to vehicles that allow us to be productive, see the world, and connect with others or is it one of the cornerstones of society's poor relationship with debt, social comparison, and inability to embrace public transportation?
Plenty of companies have generated phenomenal investment returns capturing significant value for their owners, while pushing our society further away from a long term state of flourishing.
Differentiating between creation and extraction is quite complex in the moment, and can even still be pretty murky in hindsight.
This third form of investing is more akin to actively selecting companies than indexing, but the filter with which those companies are evaluated is quite different from only maximizing profit and minimizing volatility.
Additional Reading
Shadows and light by Seth Godin
Is there any perfect company? by Sherrie Johnson Smith
69 | In Defense of Actively Picking Companies: A Walk Down Franklin Street
Actively picking companies is a style of investing in which, instead of owning the entire group of companies available, you decide to intentionally own a subset of companies from a group.
This is how investments have been evaluated since the very first investment opportunity came about - investment opportunity presented, due diligence performed, and decision to own or pass on ownership made.
Actively selecting companies implies a belief that individuals have the ability to evaluate, buy, and hold companies whose value will increase more than the value of other companies over time.
A Walk Down Franklin Street
I went to school at UNC-Chapel Hill from 2006 to 2011. Four years of undergrad followed by one year of grad school.
The campus buts up against Franklin Street - a bustling street full of restaurants, retailers, condos, and all other types of businesses that are often packed with people, especially during most Marchs and Aprils.
Some storefronts have been the same for decades and others have turned over every other summer for decades.
Franklin Street isn't that different from hubs of activity in cities and towns across the world - its history is marked by companies that have stuck around, newcomers that have taken off, and old and new companies alike that have gone belly up.
Some of the businesses have been around for ages and seem like they could stick around for ages more...
- Top of the Hill
- Yogurt Pump
- Julian's
- Chapel Hill Tire
- The Carolina Inn
- The Bicycle Chain
- Sutton's
- Cat's Cradle
- Johnny T-Shirt
Some of the businesses have popped up in recent years and have become stalwarts of their own very quickly…
- Al's Burger Shack
- Target
- Trader Joe's
- Hampton Inn
Some quality businesses have succumbed to the harsh reality that all business can't last forever...
- Ye Olde Waffle Shop
- The Rathskellar
- Walgreens
- Spanky's
Some businesses were bad ideas or sketchy from the start and failed immediately, or worse, are still limping along today. Out of respect, I won't list these by name.
I'd wager that many people could have "predicted" some of these outcomes - maybe not the precise timing or the magnitude of failure, but certainly the inevitability of failure.
The reality is that an investment in any of the companies in the first group or second group could have returned 10x or 100x or 1,000x, while those in the third group and fourth group may have not returned the initial investment to an owner.
If given $100,000 to invest in any mixture of these companies, how could you not make an honest effort to pick the ones that would stick around and avoid the ones that seemed destined to fail?
68 | In Defense of Actively Picking Companies: You Can See It and You Can Feel It
Actively picking companies is a style of investing in which, instead of owning the entire group of companies available, you decide to intentionally own a subset of companies from a group.
This is how investments have been evaluated since the very first investment opportunity came about - investment opportunity presented, due diligence performed, and decision to own or pass on ownership made.
Actively selecting companies implies a belief that individuals have the ability to evaluate, buy, and hold companies whose value will increase more than the value of other companies over time.
You Can See It and You Can Feel It
Almost everyone can spot a good company when they see it.
If you can't see it, then you can certainly feel it.
Customer service that makes you feel like family. A sterling reputation in the community. Rave reviews that spread like wildfire. Lines out the door. Immediate sell outs of products and services. Owners and employees who are “cut from a different mold”.
Without looking at the numbers, I think most of us can identify companies that will outperform, last longer, and add more value to society than others.
The types of companies that lead people to say, "If only I could have bought a share of that company 20 years ago!" after a single interaction.
The characteristics of a successful business are often easy to observe firsthand.
The reality is that these things don't change just because the company isn't located in our neighborhood, or the company operates in an industry that we don't interact with each day.
Identifying and owning these companies is at the core of the active investing philosophy - some companies will perform better than others and others will not keep up, so be sure you pick the right ones.
Of course, there is a cost to selecting these companies. Someone must experience the customer service, feel the reputation, hear the reviews, see the lines, account for the sell outs, and talk to the employees, and this work requires some mixture of capital, time, attention, and energy to be expended.
This task is easier on paper than it is in practice, but history has shown us that the people who can do it well can generate significant investment returns.
67 | In Defense of Actively Picking Companies: Winners and Losers
Actively picking companies is a style of investing in which, instead of owning the entire group of companies available, you decide to intentionally own a subset of companies from a group.
This is how investments have been evaluated since the very first investment opportunity came about - investment opportunity presented, due diligence performed, and decision to own or pass on ownership made.
Actively selecting companies implies a belief that individuals have the ability to evaluate, buy, and hold companies whose value will increase more than the value of other companies over time.
Winners and Losers
If there is one reality with investing, it is that there will always be winners and there will always be losers.
Every investment decision has two parties, one that is buying and becoming an owner and one that is selling and giving up their ownership.
From that point forward, if the value goes up then the new owner "wins" and the old owner "loses".
If the value goes down, then the new owner "loses" and the old owner "wins".
This fact alone would lead you to believe that it's important to know more about the investment than the other party to the transaction.
Like most other things in life, a more experienced, knowledgeable person is more likely to outperform a rookie.
A chef is going to plan a meal, acquire supplies for a meal, and cook a better meal than a rookie cook 100 times out of 100.
A marathon runner is going to prepare more efficiently, have a reduced risk of injury, and outpace a rookie runner 100 times out of 100.
A plumber is going to bring the right tools, access the pipes more effectively, and eliminate a leak more quickly than a rookie homeowner 100 times out of 100.
Understanding the company's financial health, the quality of its employees, the quality of its relationships with stakeholders, its standing within its industry, or the potential future demand for its products and services is integral to making a good decision about whether to own it or not.
Winners and losers are inherent to the system, so spending a little time trying to increase the odds that you can become one of the winners is table stakes for successful investing.
66 | In Defense of Indexing: Meet People Where They Are
Indexing is a style of investing in which, instead of intentionally selecting a subset of companies from a group, you decide to own the entire group.
Groups of companies come in all shapes and sizes - a group could be all of the big companies in the United States, all of the energy companies in the world, all of the small companies in developing countries, or any other combination of geographies, industries, or company sizes.
Indexing meets people where they are.
When it comes to investing, many people struggle to understand and fully appreciate the details of a specific investment strategy. This is not a problem - real limits of time, experience, and interest create significant barriers to developing even a baseline understanding of investing. Indexing acknowledges this reality.
We know that relative wealth is more important to people than absolute wealth. We also know that people feel the pain of losses more than the pleasure of gains. Indexing allows your investing experience to be like many people instead of different from most. Inherently, indexing allows you to “keep up” with others in seasons of positive returns and ensures that you don’t “lose ground” relative to others in seasons of negative returns.
We know that people dislike paying taxes, particularly when they might not fully appreciate or understand why they are paying them. The feelings are compounded when taxes are generated from one account and the tax bill is paid out of a bank account many months later. Indexing reduces turnover which in turn reduces ongoing taxes.
We know that people dislike paying fees, particularly when they might not fully appreciate or understand why they are paying them too. Given our human tendency to demand short term results and feel losses more acutely than gains, it can be extra difficult to pay fees and see an index fund outperform a more expensive investment even for a brief season. Indexing requires minimal due diligence in company selection which continues to drive fees towards zero.
We also know that simplicity beats complexity. Outside of buying individual stocks and bonds, indexing is about as simple as investing gets – a group of companies and you own them all. No layers of decision-makers, portfolio managers, fund managers, or unnecessary complexity and activity to abstract what is actually happening.
Whether an investment expert or purist likes indexing or not, it meets people where they are.
Additional Reading
Good Enough by Morgan Housel
The Error-Proof Portfolio: Why the Best Questions Might Be the 'Dumb' Ones by Christine Benz
65 | In Defense of Indexing: Capture the Upside
Indexing is a style of investing in which, instead of intentionally selecting a subset of companies from a group, you decide to own the entire group.
Groups of companies come in all shapes and sizes - a group could be all of the big companies in the United States, all of the energy companies in the world, all of the small companies in developing countries, or any other combination of geographies, industries, or company sizes.
Indexing knows that capturing the upside is more important than avoiding the downside.
It's easy to think that avoiding companies that struggle or under perform is the most important part of successful investing.
The reality is that the bigger risk is missing out on owning the companies that out perform.
While psychologically this might seem backwards. Mathematically it is pretty simple.
If you own a company that fails, the maximum amount that you can lose in that single investment is 100%.
On the flip side, if you own a company that is wildly successful you can gain 100%, 200%, 500%, or 1,000%+ on that single investment.
It's pretty easy to see that one successful company can offset and totally wipe out the under performance of one or multiple struggling companies.
Indexing ensures that you own all the companies in a given group and, even though you might include a few companies that struggle, it ensures that you also hold all of the companies that exceed expectations.
Additional Reading
Tails, You Win by Morgan Housel
Portfolio thinking by Seth Godin
64 | In Defense of Indexing: More Humility than Naivete
Indexing is a style of investing in which, instead of intentionally selecting a subset of companies from a group, you decide to own the entire group.
Groups of companies come in all shapes and sizes - a group could be all of the big companies in the United States, all of the energy companies in the world, all of the small companies in developing countries, or any other combination of geographies, industries, or company sizes.
Indexing is more humility than naivete.
Carl Richards says, "Risk is what's leftover after you've thought of everything."
The list of things that could cause any single company to fail is literally endless.
To name a few...Pandemic. Natural disaster. Bad product launch. Poor culture. Bad accounting. Unexpected lawsuit. Rogue employee. Cyber security breach. Volatile CEO. Bad relationship with a supplier. Angry customers on social media. New legislation. Rising interest rates. Falling interest rates. And a million more things.
To even pretend that someone could have a pulse on this endless list of things that could go wrong is almost comical. If the CEO of a company can't do it, how in the world is an investor outside of the company going to have a chance of doing it?
This is the challenge of selecting 1 company to perform well, much less a portfolio of 30, 100, or 500 companies.
On top of that, this only addresses the "numbers" side of the investing equation. Gleaning from Morgan Housel, the "story" side of the equation is just as vital and depends on the past, current, and future emotions, feelings, thoughts, and beliefs of the 7+ billion people on the planet and their perception of each business.
If you thought evaluating the company for its merits alone was challenging, good luck trying to reconcile your analysis to the rest of the world.
Indexing acknowledges that all risks that can run a business into the ground are created equally and that trying to keep tabs on them all is an endless, time-consuming endeavor.
Instead of attempting to play an unwinnable game, indexing is a humble acknowledgement that a game that can't be won does not need to be played.
Additional Reading
The natural size by Seth Godin
A Number From Today and A Story About Tomorrow by Morgan Housel
Market forecasting isn’t like the weather… by Carl Richards